This is a guest post by Ray Sin, a doctoral candidate in sociology at the University of Illinois-Chicago, is an Associate Behavioral Researcher at Morningstar Inc.
What is Morningstar? What exactly do you do at Morningstar? What has sociology got to do with finance?
These are some of the most common reactions when I tell folks, particularly family and most recently at ASA’s Annual Meeting, that I work at Morningstar. Initially, taken aback by the number of questions, like any good sociologist, I quickly realized that there was a pattern: how does our training in sociology translate into the seemingly distant world of finance? My answer comes in different parts. I begin by explaining what Morningstar does, elaborating on what the Behavioral Insights Team, the team I’m part of at Morningstar, is, and relating sociology back to both of them.
What Does Morningstar Do?
What draws many of us to sociology is our desire to improve the human condition, generally by identifying and ameliorating social inequalities. At Morningstar, one of the core values is to always put the interest of investors first. This occurs in two distinct but interrelated ways. The first is providing the most rigorous independent investment research and data so that investors can make informed investment decisions. The second is to improve our understanding of investors so that we can help them achieve their financial goals.
(Kinnel, Russel. “Mind the Gap 2016,” Morningstar.com, June 14, 2016 http://news.morningstar.com/articlenet/article.aspx?id=756711)
The first graph documents what’s known as the “behavior gap” or the investor returns gap. Morningstar’s analysis shows that across all funds from 2005 to 2015, an average investor earns far less (53 basis points, or 0.5%) from their investments than if they had invested at the beginning of the period and held onto their investments. Simply put, this gap occurs because many everyday investors are not making the best decisions: buying and selling at the wrong time therefore reducing their ability to meet their financial goals.
(Data Source: Bureau of Economic Analysis)
The second figure portends a retirement crisis. Americans are projected to face a retirement savings gap of $4.38 trillion. Yet, and paradoxically, Americans’ retirement confidence (belief that they would have enough money to live comfortably throughout their retirement years) is rising. There is disconnect between their perception of their ability to retire and their actual savings behavior.
On the surface, one could individualize these issues as personal troubles. However, from our sociological training, we know better. These seemingly private problems are actually reflective of larger social problems. In reality, we all have the tendency to panic and withdraw our investments during market corrections. We all desire to retire comfortably but many of us focus on meeting our present, rather than our future, needs. The challenge is to identify these behavioral patterns and devise ways to overcome them.
This is where behavioral science fits in. Investing is not only the movement of capital. It is about the science of judgment and decision-making, the embeddedness of investors within a large social network or ecosystem and, increasingly, the complex interface between technology and humans. And investing is not just about the purchasing of mutual funds, stocks, and bonds. It is also about saving for retirement. In short, it is about people—people who invest.
Building Bridges–Behavioral Science and Finance
Behavioral science is an umbrella term signifying the synthesis of theories and concepts, primarily from psychology, sociology, and economics, about human behavior. Behavioral finance is an application of behavioral science to finance.
One of the central questions in behavioral finance is understanding how people make retirement savings and investment decisions. Building from the classical economic premise of rationality, investors were assumed to be rational wealth-maximizing actors. However, psychologist Daniel Kahneman and his colleagues challenged this assumption by showing that we often suffer from cognitive biases that lead to less-than-rational behaviors, including saving for retirement and investing. Though we strive to act in our own best interests, more often than not, we don’t, at times even unconsciously so. While older models highlight what a rational actor ought to do, a behavioral science model focuses on what an actor actually does! It is this shift towards understanding why investors do not always make rational decisions that laid the foundation of behavioral economics, and, in general, behavioral science. Kahneman won a Nobel Prize in 2002.
Behavioral Science in Action–Behavioral Insights Team at Morningstar
On the Behavioral Insights Team at Morningstar, we apply behavioral science concepts and theories to identify and rectify behavioral obstacles associated with investing. We then test our ideas using randomized controlled trials and disseminate our insights through our software, books (see here and here), policy briefs, white papers, and op-eds. Our challenge is to develop and test different interventions to help people overcome behavioral obstacles.
To explain, let’s circle back to the two examples presented earlier and apply a behavioral lens. One of the main factors contributing to the behavioral gap in investing is poor investment timing. Investors tend to increase their investments when the market is doing well (overconfidence bias) and pull them out during market downturns (panic selling). Resultantly, this is equivalent to buying high and selling low–the opposite of what you should do! Knowing these patterns gives us, on the Behavioral Insights Team, a clue about where to devise interventions to minimize the effects of overconfidence during market upswings and prevent panic selling when the market contracts.
Similarly, studies show that even though many people desire to save money, they often fail to do so (intention-action gap). The failure to save, especially on a regular basis, has a tremendous negative effect across a variety of outcomes—from one’s ability to weather through unexpected crises to one’s ability to retire comfortably and on time. On the Behavioral Insights Team, we draw on the research literature and our own theories to devise interventions that help people cross this gap and save for retirement.
So What Does Sociology Have to Offer?
Our strengths as sociologists are our (a) multi-paradigmatic tradition (what many see as foundational work of sociology, comprising of Marx, Weber, and Durkheim, are now heavily challenged and revised); (b) multi-methods training (I am referring to our diversity of methods— ethnography, in-depth-interviews, numerous regression models, experimental design, big data and machine learning, and the list goes on); and (c) empiricism (emphasizing empirically based evidence that is rooted in falsifiability).
What this means is that, as sociologists, we learn to integrate disparate sets of literatures, often beyond disciplinary boundaries. We are proficient in a variety of research methods/designs and their attendant interpretations of the results, while remaining cognizant of their relative strengths and weaknesses. And at the end of the day, most sociologists aim to understand three things: attitudes, behaviors, and the interaction of the two.
And this is what I do (well, mostly) at Morningstar—conduct research (experiments and observational studies), synthesize literature, gather data, analyze results, and write. I also work with external researchers, primarily academics at some of the top universities across the world, as part of our Behavioral Science Advisory Board. If that sounds similar to a faculty position (sans teaching), that’s because it is! Not only do I get a chance to use the skills that I have as a sociologist and continue to collaborate with some of the leading researchers around the world, I also have the opportunity to pick up new ones (e.g. SQL, R etc). As I’m writing this, I cannot help but feel fortunate and incredibly privileged to be in my current position.
Looking Back and Moving Forward
Five years ago, I would have said “heck no!” to working in a non-academic position. Part of that is ignorance. Like many of my peers, the impression that I had was that the only place to do rigorous research is at universities. Generally, PhD programs train you to join university faculty. If you really love the scientific enterprise (which I do), you are expected, more or less, to be a professor. The market has changed tremendously. Today, there is more than one way to ‘do’ sociology.
One of the new opportunities to do sociology lies in industry. As sociologists, we can help answer some pressing business questions (e.g. what do our clients want? How can we better serve them?). Understanding what people think and how they behave—isn’t that the bread and butter of sociology? Doing sociology in industry does not mean you have to forsake what may have brought you to sociology—improving the human condition. There is demand for sociologists in people-analytics (improving diversity and wellness in the workplace) and policy-oriented positions to improve the quality and delivery of social services to the underprivileged, just to name a few.
How do we close the perceived chasm between sociology and finance; between academia and industry? Here are some of my preliminary ideas.
The first is to have a more open dialogue between economic sociology and behavioral finance. No doubt there has been good work in economic sociology and finance (see here, here, and here) and productive debates regarding disciplinary boundaries. However, sociological work on finance largely has been centered on firm- or market-level analyses. We have limited studies on sociological understandings of individual people and their investment behaviors.
The second is to foster more collaboration between researchers at universities and individuals like me in industry. Our external research colleagues tend to be psychologists or economists in business schools. I would like to include sociologists who are interested in better understanding investor behaviors.
The third is preparing the next generation of sociologists who are interested in research but not necessarily within the strictures of the ivory tower. To better leverage our strengths in empiricism and promote ourselves as theoretically grounded data scientists, we need to restructure our PhD programs to include cross-disciplinary insights such as formal theory, econometrics, and basic coding. This may be an opportunity for sociologists (and ASA) to rethink and expand what ‘doing’ sociology means. There is a growing demand for sociologists in non-traditional career paths in industry, particularly in data-centered careers. The question is how prepared are we to take advantage of this opportunity?
In Michael Burawoy’s insightful recent essay on sociology as a vocation, he argues for a renewed commitment to continue in our ‘vocation’ to improve the human condition by engaging and resisting neoliberalism. With the decline in federal and state funding for higher education and expansion of adjunctification, this critical essay is both timely and necessary. While I wholeheartedly agree with most of the essay, I would like to push back at his concluding remark that sociologists need to “[summon] up the courage to contest this latest waves of marketization that threatens to overwhelm not just ourselves but the human race” (p. 392). I’m not disagreeing that the systematic defunding and corporatization of higher education is a trend that should be resisted. Rather, instead of blindly running against the winds of change, it may be productive to figure out how to carve out new opportunities.
For example, corporate social responsibility, though not a brand new concept, has expanded rapidly and morphed into new exciting ways such as sustainable investing. Ameliorating social problems and inequalities are now “marketised” – people and businesses want to strike a balance between doing good and doing well. This is a great opportunity for sociologists to test our ideas on how to ameliorate social inequalities outside of the ivory tower, and consequently, remaking capitalism into a socially responsible one. A lofty goal? Sure! But isn’t that what brought us into sociology in the first place?